Order of setting off of losses & deductions against Business /profession Income

Order of setting off of losses and deductions under profits and gains of business or profession

A business in its normal course of business can incur losses on account of various reasons. One of the reason being heavy deductions and exemptions given by the government  under the Income Tax Act,1961 in order to encourage the expansion of existing business or set up new business. Deductions on account of accelerated depreciation, investment allowance, development rebate are some examples whereby the tax payer is given the incentive to grow/create business. These deductions can be claimed in the current year as well as carried forward by the assessee. Things get a bit complicated if the tax payer has earned profits and has unabsorbed balances of losses and one or more incentives as mentioned above. Supreme Court in Seshasayee Paper & Boards Limited mentions that the order of set off is pretty clear on the combined reading of sections under the law. However section by section analysis is nowhere discussed in the case law. The same is presented as under:

A. Section 32(1): Normal Deprecation

‘In respect of depreciation of—

i….

ii….

owned, wholly or partly, by the assessee and used for the purposes of the business or profession, the following deductions shall be allowed’

Therefore depreciation under section 32(1) has to be deducted while computing profits and gains from business or profession.

B. Section 32(2): Unabsorbed depreciation

Where, in the assessment of the assessee, full effect cannot be given to any allowance under sub-section (1) in any previous year, owing to there being no profits or gains chargeable for that previous year, or owing to the profits or gains chargeable being less than the allowance, then, subject to the provisions of sub-section (2) of section 72 and sub-section (3) of section 73, the allowance or the part of the allowance to which effect has not been given, as the case may be, shall be added to the amount of the allowance for depreciation for the following previous year and deemed to be part of that allowance, or if there is no such allowance for that previous year, be deemed to be the allowance for that previous year, and so on for the succeeding previous years.

C. Section 72(2) Carry forward and set off of business losses:

‘Where any allowance or part thereof is, under sub-section (2) of section 32 or sub-section (4) of section 35, to be carried forward, effect shall first be given to the provisions of this section’.

Therefore, brought forwards losses should be set off before section 32(2)

D. Section 73(3) Losses in speculation business:

‘In respect of allowance on account of depreciation or capital expenditure on scientific research, the provisions of sub-section (2) of section 72 shall apply in relation to speculation business as they apply in relation to any other business’ i.e. treatment should be similar as mentioned in section 72(2)

E. Section 32A (3) Investment allowance:

‘Where the total income of the assessee assessable for the assessment year relevant to the previous year in which the ship or aircraft was acquired or the machinery or plant was installed, or, as the case may be, the immediately succeeding previous year (the total income for this purpose being computed after deduction of the allowances under section 33 and section 33A, but without making any deduction under sub-section (1) of this section or any deduction under Chapter VI-A) is nil or is less than the full amount of the investment allowance,—‘

Therefore allowances under section 33 and 33A have to be given a preference before section 32A

F. Section 33(2) Development rebate:

‘In the case of a ship acquired or machinery or plant installed after the 31st day of December, 1957, where the total income of the assessee assessable for the assessment year relevant to the previous year in which the ship was acquired or the machinery or plant installed or the immediately succeeding previous year, as the case may be (the total income for this purpose being computed without making any allowance under sub-section (1) or sub-section (1A) of this section or sub-section (1) of section 33A or any deduction under Chapter VI-A) is nil or is less than the full amount of the development rebate calculated at the rate applicable thereto under sub-section (1) or sub-section (1A), as the case may be,’

Therefore section 33(2) will be given a priority above section 33A.

G. Summary Table:

Hope the article shall be of use to the readers at large.

(Author is currently working with SKP Business Consulting LLP)

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(Republished with Amendments by Team Taxguru)